{"id":13063,"date":"2024-03-25T18:05:58","date_gmt":"2024-03-25T18:05:58","guid":{"rendered":"https:\/\/zacksim.com\/blog\/?p=13063"},"modified":"2024-03-25T18:05:58","modified_gmt":"2024-03-25T18:05:58","slug":"what-do-rising-corporate-debt-defaults-mean-for-the-economy","status":"publish","type":"post","link":"https:\/\/zacksim.com\/blog\/what-do-rising-corporate-debt-defaults-mean-for-the-economy\/","title":{"rendered":"What Do Rising Corporate Debt Defaults Mean For The Economy?"},"content":{"rendered":"\n

What Rising Corporate Debt Defaults Tell Us About the Economy<\/strong><\/p>\n\n\n\n

For the past couple of years, investors and analysts have been debating how higher interest rates and the possibility of a recession would ripple through corporate debt markets. A major concern was the so-called \u201cmaturity wall\u201d of debt coming due. Many corporations\u2014especially those in the high-yield category\u2014were likely facing the painful reality of having to refinance \u2018cheap\u2019 (post-pandemic, pre-inflation) debt at much higher rates.<\/p>\n\n\n\n

In a sense, some of these fears and concerns have come to fruition. In 2023, corporate debt defaults rose to 153 (from 85 in 2022), and through mid-March, the tally was already at 29\u2014the highest Q1 total since the Global Financial Crisis. The numbers alone suggest that corporations are having trouble accessing debt markets, and are struggling to generate the cash flow needed to pay interest due on debt, or both.1<\/sup><\/p>\n\n\n\n

But there\u2019s more to the story beyond these numbers.<\/p>\n\n\n\n

When investors want to check in on corporate financial health, they should generally start with credit markets. The question to pose is: what is the implied cost of refinancing bonds, both for investment-grade corporations and the high-yield\/junk category?<\/em> One might expect that with rising defaults and higher interest rates, refinancing debt is not only more expensive but also quite prohibitive for many.<\/p>\n\n\n\n

Corporate Debt Defaults Pose a Risk, but What About Current Market Opportunities?<\/a><\/span><\/strong><\/p>\n\n\n\n

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Credit spreads tell us otherwise.<\/p>\n\n\n\n

For junk-rated bonds, the implied cost of refinancing bonds is at its lowest level since May of 2022, and investment-grade bonds are at their cheapest since the summer of 2022. As seen in the chart below, credit spreads appear to be locked in a downward trend, having weathered the Fed\u2019s aggressive rate hike campaign and the regional bank stress one year ago.<\/p>\n\n\n\n

High Yield Option-Adjusted Spread (red line) & Baa Corporate Bond Yield Relative to 10-Year U.S. Treasury (blue line)<\/em><\/strong><\/p>\n\n\n\n

\"\"
Source: Federal Reserve Bank of St. Louis3<\/sup><\/em><\/strong><\/figcaption><\/figure>\n\n\n\n

It follows that on average, a company issuing junk bonds today to replace maturing bonds would only be adding about 175 basis points to its annual interest bill, compared to nearly 500 basis points if the company refinanced in October 2022. The picture for investment-grade bonds looks similar.<\/p>\n\n\n\n

If we take the above chart and zoom out to look back at the past 25+ years, it becomes apparent that spreads are not only at historically low levels, they are also at levels that corresponded to strong economic growth previously.<\/p>\n\n\n\n

High-Yield and Baa Corporate Bond Spreads (1998 \u2013 Present)<\/em><\/strong><\/p>\n\n\n\n

\"\"
Source: Federal Reserve Bank of St. Louis4<\/sup><\/em><\/strong><\/figcaption><\/figure>\n\n\n\n

Readers may wonder: if credit spreads are so low and corporate debt markets are seeing a flurry of activity, then how do you explain the rise of defaults in 2023 and year-to-date 2024?<\/em><\/p>\n\n\n\n

The answer is that credit markets give us insight into present and future conditions for corporations, while defaults tell us more about the past\u2014i.e., how a recession or tighter financial conditions ultimately affected businesses. In other words, recent defaults are telling us how industry struggles and Fed rate hikes in 2022 and 2023 ultimately caused a handful of companies to buckle, while credit spreads (the market) help us understand what corporations are experiencing today and what lies ahead.<\/p>\n\n\n\n

Bottom Line for Investors<\/strong><\/p>\n\n\n\n

Aiding in the positive environment for corporate borrowing has been the anticipation of rate cuts later this year. The hope for lower borrowing costs in the future has nudged many investors to take a risk-on mindset in corporate bond markets, and companies have been responding in kind by issuing more debt\u2014the supply of corporate bonds globally is 30% higher in 2024 year-to-date as compared to the same period last year.<\/p>\n\n\n\n

Overall, U.S. corporations remain in a strong financial position, as evidenced by record levels of investment (chart below), strong balance sheets, and projected earnings growth in 2024.<\/p>\n\n\n\n

\"\"
Source: Federal Reserve Bank of St. Louis5<\/sup><\/em><\/strong><\/figcaption><\/figure>\n\n\n\n

Corporate debt defaults could continue to rise as the year progresses, perhaps setting off some alarms in financial media. But as long as credit spreads remain relatively low, I think investors can reasonably interpret defaults as telling us what the economy endured in the past\u2014not where it\u2019s heading in the future.<\/p>\n\n\n\n

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If you have $500,000 or more to invest and want to learn more about our market forecasts for 2024, click on the link below to get your free report today!<\/p>\n","protected":false},"excerpt":{"rendered":"

Corporate debt defaults have risen in 2023 and early 2024\u2014but while this trend sounds alarming, it tells us more about the past than the present and future.<\/p>\n","protected":false},"author":3,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[63,71],"tags":[],"class_list":["post-13063","post","type-post","status-publish","format-standard","hentry","category-mitch-on-the-markets","category-private-client-group"],"acf":[],"_links":{"self":[{"href":"https:\/\/zacksim.com\/blog\/wp-json\/wp\/v2\/posts\/13063","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/zacksim.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/zacksim.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/zacksim.com\/blog\/wp-json\/wp\/v2\/users\/3"}],"replies":[{"embeddable":true,"href":"https:\/\/zacksim.com\/blog\/wp-json\/wp\/v2\/comments?post=13063"}],"version-history":[{"count":2,"href":"https:\/\/zacksim.com\/blog\/wp-json\/wp\/v2\/posts\/13063\/revisions"}],"predecessor-version":[{"id":13068,"href":"https:\/\/zacksim.com\/blog\/wp-json\/wp\/v2\/posts\/13063\/revisions\/13068"}],"wp:attachment":[{"href":"https:\/\/zacksim.com\/blog\/wp-json\/wp\/v2\/media?parent=13063"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/zacksim.com\/blog\/wp-json\/wp\/v2\/categories?post=13063"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/zacksim.com\/blog\/wp-json\/wp\/v2\/tags?post=13063"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}